Watching China: U.S. Economic Leadership Loss Is Less Than Certain

One of the reasons I became an analyst is that I couldn't rely on most of the projections my predecessors sold because they didn't take into account critical future events. I was faced with a constant barrage of predictions that assumed that trends would continue unchanged, and in every case these predictions failed at some point. Things change and those changes can break trends. If those breaks aren't anticipated, then those that bet on these forecasts make bad bets. I watched a division I worked with nearly get wiped out by one such event.

China appears unstoppable; as a country, it is investing massively in technology and infrastructure. Its major cities, in just a few short years, have gone from trailing to leading architectural marvels. It has a massive trade surplus. As I mentioned a few days ago, Dell is betting heavily that China is the next big market and, by any measure it should be. But all things aren't that rosy. China could, and probably will, hit a wall. Plus, the wakeup call that the U.S. just got could allow it to come back, suggesting there is an alternative view.

China the Great Emulator

China's strength remains in emulation, not leadership. This became clear when I was driving into Shanghai the other day. It has the only Maglev train system in general use. It was built by Siemens with substantial Chinese help. When you look into the train cab, you will see a marvel of engineering, with one of the most advanced control systems ever to exist in a train. Then, in the corner, you see a Chinese air conditioning system. It's the same type you can find in most Fry's electronics stores for under $400 -- designed for the home with a dryer hose leading to the outside of the train. Future trains will be built by China using what was learned by working with Siemens. In short, they will be copies of what Siemens did, but that air conditioning system doesn't give me a great deal of confidence that they really grasp the need for industrial-grade components in systems that can move at 400 miles per hour.

Emulating others initially, as Japan also did, is fine, but at some point you have to step out and drive the market. Otherwise, the country's growth is slowed because it can't solve a problem. It has to wait for someone else to solve it so the solution can be emulated. Using the train example, China will have the greatest number of Maglev trains, which means it will have problems that Siemens and others haven't been faced with yet. If China can't innovate out of these problems, the effort will stall and possibly fail spectacularly.

To solve this, China has to protect intellectual property so industry can shift from emulation to invention (plus some more emulation). It hasn't made that move yet. Until it does, and it's making slow progress, the emulator will remain the major driver in China, which won't be able to sustain leadership.

Labor Troubles Coming

One of the reasons China is doing well is that labor is comparatively inexpensive. However, there is a massive move to unionize this labor. The end result is a combination of rapidly increasing labor costs and in-country inflation. Already, coastal areas of China are becoming non-competitive in terms of labor and related costs. This is forcing companies to move manufacturing inland and to other countries, like India, that are becoming increasingly less expensive to operate. Labor is becoming a problem in China.

This is good news for technology companies because, historically, China wasn't that interested in labor savings. But as labor costs increase, technology is becoming vastly more desirable -- and much of that comes from outside of China.

Oil

One of the lessons that China should have learned from the U.S. is that oil addiction is horrible and incredibly hard to get rid of. One of the changes in the U.S. that likely will be forced because of the current economic collapse is an aggressive move to oil alternatives. China, which should be leading in this shift, is increasingly oil dependent. Freeway building appears nearly out of control and, thanks to massive increases in the number of vehicles, the freeways are smog-clogged parking lots.

It is interesting to note that the Chinese government refers to the smog as fog and seems unwilling to accept the ecologic nightmare it is creating. The smog levels being created in China are so bad that the Chinese government had to bar half of the vehicles from driving and make massive cuts in manufacturing capacity so the Olympics could be held without hurting the athletes. If the Middle East erupts, it could engage Russia, and then China could find itself running dry very quickly.

Wrapping Up

Current trends have folks believing that China will pass the U.S. and leave it in the dust by 2015. However, China will face a number of significant challenges before that and the U.S. will, after the current election settles, be under massive pressure to address its economic, energy and infrastructure problems. This suggests that China may hit a wall before 2015. And the U.S. could find itself in better shape than China by that time. Those of us that live in the U.S. only have to bust our humps to make sure that this happens.

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